EconomicDevelopment

T E N T H E D I T I O N

Michael P. TodaroNew York University and the Population Council

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Stephen C. SmithThe George Washington University

ADDISON-WESLEY

xn imprint of Pearson EducationHarlow, England • London • New York • Boston • San Francisco • TorontoSydney • Tokyo • Singapore • Hong Kong • Seoul • Taipei • New DelhiCape Town • Madrid • Mexico City • Amsterdam • Munich • Paris • Milan

Contents

PrefaceCase Studies

Vll

xxvii

Part One Principles and Concepts 1:

1 Economics, Institutions, and Development:A Global Perspective 2How the Other Half Live ^ 2Economics and Development Studies 6

The Nature of Development Economics 7Why Study Development Economics? Some Critical Questions 9The Important Role of Values in Development Economics 12

Economies as Social Systems: The Need to Go Beyond Simple Economics 13What Do We Mean by Development? 14

Traditional Economic Measures 14The New Economic View of Development 15Sen's "Capabilities" Approach 16Three Core Values of Development 20The Central Role of Women 22The Three Objectives of Development 22The Millennium Development Goals 22

Conclusions 25EJ Case Study: Progress in the Struggle for More Meaningful Development: Brazil 28

2 Comparative Economic Development 39Defining the Developing World 41Measuring Development for Quantitative Comparison across Countries 43Some Basic Indicators of Development 48

A Holistic Measure of Living Levels: The Human Development Index 49Characteristics of the Developing World: Diversity within Commonality 56

Lower Levels of Living and Productivity 56

xv

xvi Contents

Lower Levels of Human Capital 58Higher Levels of Inequality and Absolute Poverty 59Higher Population Growth Rates 62Greater Social Fractionalization 63Larger Rural Populations but Rapid Rural-to-Urban Migration 64Lower Levels of Industrialization and Manufactured Exports 65Adverse Geography 66Underdeveloped Financial and Other Markets 67Lingering Colonial Impacts 68Relative Importance of the Public and Private Sectors and Civil Society 70

How Low-Income Countries Today Differ from Developed Countriesin Their Earlier Stages 71

Physical and Human Resource Endowments 72Relative Levels of Per Capita Income and GDP 72Climatic Differences 73Population Size, Distribution, and Growth 73The Historical Role of International Migration 74The Growth Stimulus of International Trade 76Basic Scientific and Technological Research and Development Capabilities 77Efficacy of Domestic Institutions -77

Are Living Standards of Developing and Developed Nations Converging? 78

Long-Run Causes of Comparative Development 82

Conclusion 88

Case Study: Divergent Development: Pakistan and Bangladesh 91

Classic Theories of Economic Growth and Development 109Classic Theories of Economic Development: Four Approaches 109

Development as Growth and the Linear- Stages Theories 110Rostow's Stages of Growth 111The Harrod-Domar Growth Model 112Obstacles and Constraints 114Necessary versus Sufficient Conditions: Some Criticisms of the Stages Model 114

Structural-Change Models 115The Lewis Theory of Development 115Structural Change and Patterns of Development 120Conclusions and Implications 121

The International-Dependence Revolution 122The Neocolonial Dependence Model 122The False-Paradigm Model 124The Dualistic-Development Thesis 124 N

Conclusions and Implications 125The Neoclassical Counterrevolution: Market Fundamentalism 126

Challenging the Statist Model: Free Markets, Public Choice, and Market-FriendlyApproaches 126

Contents xvii

Traditional Neoclassical Growth Theory 128Conclusions and Implications 129

Classic Theories of Development: Reconciling the Differences 131

E3 Case Study: Schools of Thought in Context: South Korea and Argentina 133

Appendix 3.1 Components of Economic Growth 142

Appendix 3.2 The Solow Neoclassical Growth Model 147

Appendix 3.3 Endogenous Growth Theory 151

1 Contemporary Models of Development andUnderdevelopment 158Underdevelopment as a Coordination Failure 159

Multiple Equilibria: A Diagrammatic Approach "-y~ 162Starting Economic Development: The Big Push 167

The Big Push: A Graphical Model 168Other Cases in Which a Big Push May Be Necessary 173Why the Problem Cannot Be Solved by a Super-Entrepreneur 174

Further Problems of Multiple Equilibria 176

Kramer's O-Ring Theory of Economic Development 179The O-Ring Model 179Implications of the O-Ring Theory 182

Economic Development as Self-Discovery 184

e The Hausmann-Rodrik-Velasco Growth Diagnostics Framework 185

Conclusions 188

El Case Study: Understanding a Development Miracle: China 193

Part Two Problems and Policies: Domestic ] 207|

5 Poverty, Inequality, and Development 208Measuring Inequality and Poverty 210

Measuring Inequality 210Measuring Absolute Poverty 217

Poverty, Inequality, and Social Welfare 222What's So Bad about High Inequality? 222Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies 224Kuznet's Inverted-U Hypothesis 227Growth and Inequality 232

Absolute Poverty: Extent and Magnitude 233Growth and Poverty 236

Economic Characteristics of Poverty Groups 238Rural Poverty 238

xviii Contents

Women and Poverty 239Ethnic Minorities, Indigenous Populations, and Poverty 243

Policy Options: Some Basic Considerations 244

Areas of Intervention 244

Policy Options 245

Summary and Conclusions: The Need for a Package of Policies 250• Case Study: Making Microfinance Work for the Poor:

The Grameen Bank of Bangladesh 252

Appendix 5.1 Appropriate Technology and Employment Generation:The Price Incentive Model 266

Appendix 5.2 The Ahluwalia-Chenery Welfare Index 269

6 Population Growth and Economic Development:Causes, Consequences, and Controversies 273The Basic Issue: Population Growth and the Quality

of Life 274Population Growth: Past, Present, and Future 275

World Population Growth throughout History 275Structure of the World's Population 277The Hidden Momentum of Population Growth 281

The Demographic Transition 283The Causes of High Fertility in Developing Countries:

s The Malthusian and Household Models 2861J The Malthusian Population Trap 286

Criticisms of the Malthusian Model 289The Microeconomic Household Theory of Fertility 291The Demand for Children in Developing Countries 293Some Empirical Evidence 294Implications for Development and Fertility 295

The Consequences of High Fertility: Some Conflicting Opinions 295

It's Not a Real Problem 296It's a Deliberately Contrived False Issue 297It's a Desirable Phenomenon 298It Is a Real Problem 299

Goals and Objectives: Toward a Consensus 1 302

Some Policy Approaches 303What Developing Countries Can Do 304What the Developed Countries Can Do 307How Developed Countries Can Help Developing Countries with Their Population

Programs 308

Conclusion 309

• Case Study: Population, Poverty, and Development:

China and India 310

Contents xix

7 Urbanization and Rural-Urban Migration:Theory and Policy 320The Migration and Urbanization Dilemma 320

Urbanization Trends and Projections 321The Role of Cities 327

Industrial Districts 327Efficient Urban Scale 329

The Urban Giantism Problem 331First-City Bias 332Causes of Urban Giantism 333

The Urban Informal Sector 335Policies for the Urban Informal Sector 337Women in the Informal Sector 340

Migration and Development 342Toward an Economic Theory of Rural-Urban Migration 344

A Verbal Description of the Todaro Model 345x A Diagrammatic Presentation 347

Five Policy Implications 350Summary and Conclusions: A Comprehensive Migration and Employment

Strategy 352H Case Study: Rural-Urban Migration and Urbanization in Developing Countries:

India and Botswana 355Appendix 7.1: A Mathematical Formulation of the Todaro Migration Model 366

8 Human Capital: Education and Health in EconomicDevelopment 369The Central Roles of Education and Health 369Education and Health as Joint Investments for Development 372Improving Health and Education: Why Increasing Income Is Not Sufficient 373Investing in Education and Health: The Human Capital Approach 375Child Labor 378The Gender Gap: Women and Education 382

Consequences of Gender Bias in Health and Education 384Educational Systems and Development 387

The Political Economy of Educational Supply and Demand: The Relationshipbetween Employment Opportunities and Educational Demands 387

Social versus Private Benefits and Costs 389 •,Distribution of Education 392Education, Inequality, and Poverty 394Education, Internal Migration, and the Brain Drain 396

Health Systems and Development 397Measurement and Distribution 397

xx Contentsc

Disease Burden 400HIV/AIDS 402Malaria 407Parasitic Worms and Other "Neglected Tropical Diseases" 408Health and Productivity 409Health Systems Policy 413

B Case Study: Pathways out of Poverty: Progresa/Oportunidades 416

9 Agricultural Transformation and Rural Development 431The Imperative of Agricultural Progress and Rural Development 431

Agricultural Growth: Past Progress and Current Challenges 433

The Structure of Agrarian Systems in the Developing World 438

Peasant Agriculture in Latin America, Asia, and Africa 439Agrarian Patterns in Latin America: Progress and Remaining Poverty Challenges 441Transforming Economies: Problems of Fragmentation and Subdivision

of Peasant Land in Asia 444Subsistence Agriculture and Extensive Cultivation in Africa 447

The Important Role of Women 450

The Economics of AgriculturaLDevelopment: Transition from PeasantSubsistence to Specialized Commercial Farming 453

Subsistence Farming: Risk Aversion, Uncertainty, and Survival 454The Transition to Mixed and Diversified Farming 460From Divergence to Specialization: Modern Commercial Farming 461

n Toward a Strategy of Agricultural and Rural Development:Some Main Requirements 462

Improving Small-Scale Agriculture 462Conditions for Rural Development 465

B Case Study: The Need to Improve Agricultural Extension for WomenFarmers: Kenya 468

10 The Environment and Development 483Economics and the Environment 483

Environment and Development: The Basic Issues ' 485Sustainable Development and Environmental Accounting 485Population, Resources, and the Environment 486Poverty and the Environment 486Growth versus the Environment 487Rural Development and the Environment 487Urban Development and the Environment 488The Global Environment and Economy 488The Nature and Pace of Greenhouse Gas-Induced Climate Change 489Natural Resource-Based Livelihoods as a Pathway out of Poverty:

Promise and Limitations 489

Contents xxi

The Scope of Environmental Degradation: An Overview 490

Rural Development and the Environment: A Tale of Two Villages 491

Global Warming and Climate Change 494

Traditional Economic Models of the Environment 497Privately Owned Resources 497Common Property Resources 499Public Goods and Bads: Regional Environmental Degradation and the

Free-Rider Problem 501 c

Limitations of the Public-Good Framework 503Urban Development and the Environment 503

The Ecology of Urban Slums 503Industrialization and Urban Air Pollution 505Problems of Congestion, Clean Water, and Sanitation 508 :~

The Need for Policy Reform 509The Local and Global Costs of Rain Forest Destruction 510Policy Options in Developing and Developed Countries 512

s What Less Developed Countries Can Do 512How Developed Countries Can Help LDCs 514What Developed Countries Can Dt> for the Global Environment 515

O Case Study: Economic Growth and Environmental Sustainability:The Philippines 517

11 Development Policymaking and the Roles of Market,State, and Civil Society 530The Planning Mystique 531

The Nature of Development Planning 532Basic Concepts 532Planning in Mixed Developing Economies '" 532

The Rationale for Development Planning 533

The Planning Process: Some Basic Models 535

Aggregate Growth Models: Projecting Macro Variables * 535

Multisector Models and Sectoral Projections 538Project Appraisal and Social Cost-Benefit Analysis 539

Conclusions: Planning Models and Plan Consistency 542Problems of Plan Implementation and Plan Failure 543

Theory versus Practice 543Reasons for Plan Failure 544

Government Failure and the Resurgent Preference for Markets over Planning 545

The Market Economy 546Sociocultural Preconditions and Economic Requirements 546Role and Limitations of the Market in LDCs 549

xxii Contents

The Washington Consensus on the State Role in Development andIts Limitations 551

Toward a New Consensus 552Development Political Economy: Theories of Policy Formulation

and Reform 554Understanding Voting Patterns on Policy Reform 556Institutions and Path Dependency 557Democracy versus Autocracy: Which Facilitates Faster Growth? 558Development Roles of NGOs and the Broader Citizen Sector 560

Trends in Governance and Reform 566Tackling the Problem of Corruption 566Decentralization 568Development Participation 570 ' ; i

Development Policy and the State: Concluding Observations 572

Case Study: The Role of Development NGOs: The BRAC Model 574

Part Three Problems and Policies: International and Macro 587

12 International Trade Theory and Development Strategy 588Globalization: An Introduction 588

International Trade and Finance: Some Key Issues 591

Five Basic Questions about Trade and Development 594

Importance of Exports to Different Developing Nations 595

Demand Elasticities and Export Earnings Instability 597

The Terms of Trade and the Prebisch- Singer Thesis 598

The Traditional Theory of International Trade 599Comparative Advantage 599Relative Factor Endowments and International Specialization:

The Neoclassical Model 600

Trade Theory and Development: The Traditional Arguments 605

The Critique of Traditional Free-Trade Theory in the Contextof Developing-Country Experience 606

Fixed Resources, Full Employment, and the International Immobility ofCapital and Skilled Labor 607

Fixed, Freely Available Technology and Consumer Sovereignty 610Internal Factor Mobility, Perfect Competition, and Uncertainty: Increasing Returns,

Imperfect Competition, and Issues in Specialization 611The Absence of National Governments in Trading Relations 613Balanced Trade and International Price Adjustments 614Trade Gains Accruing to Nationals 614

Some Conclusions on Trade Theory and Economic Development Strategy 615

Contents xxiii

Traditional Trade Strategies for Development:Export Promotion versus Import Substitution 618

Export Promotion: Looking Outward and Seeing Trade Barriers 620Import Substitution: Looking Inward but Still Paying Outward 623The IS Industrialization Strategy and Results 626Foreign-Exchange Rates, Exchange Controls, and the Devaluation Decision 631

Trade Optimists and Trade Pessimists: Summarizing the Traditional Debate 635Trade Pessimist Arguments 635 o

Trade Optimist Arguments 636The Industrialization Strategy Approach to Export Policy 637

Reconciling the Arguments: The Data and the Consensus 640

South-South Trade and Economic Integration: Looking Outwardand Inward ~ 641

Economic.Integration: Theory and Practice 641Regional Trading Blocs and the Globalization of Trade 643

Trade Policies of Developed Countries: The Need for Reform 645• Xase Study: A Development Success Story: Taiwan 649

13 Balance of Payments, Developing-Country Debt,and the Macroeconomic Stabilization Controversy 667The Balance of Payments Account 668

General Considerations 668A Hypothetical Illustration: Deficits and Debts 670

Financing and Reducing Payments Deficits 671Some Initial Policy Issues 671Trends in LDC Balance of Payments 673

The Debt Crisis of the 1980s 674Background and Analysis 674Origins of the Debt Crisis 676

Attempts at Alleviation: Macroeconomic Instability, IMF Stabilization „Policies, and Their Critics 679

The IMF Stabilization Program 679Tactics for Debt Relief 681

"Odious Debt" and Its Prevention 688

Resolution and Continued Vulnerabilities 689

• Case Study: Trade, Capital Flows, and Development Strategy: South Korea 693

Appendix 13.1: A Brief History and Analysis of the InternationalMonetary Fund and the World Bank 704

14 Foreign Finance, Investment, and Aid: Controversiesand Opportunities 714The International Flow of Financial Resources 714

xxiv Contents

Private Foreign Direct Investment and the Multinational Corporation 715Multinational Corporations: Size, Patterns, and Trends 716Private Foreign Investment: Some Pros and Cons for Development 719Private Portfolio Investment: Boon or Bane for LDCs? 725

The Role and Growth of Remittances 726

Foreign Aid: The Development Assistance Debate 728Conceptual and Measurement Problems 728Amounts and Allocations: Public Aid 730Why Donors Give Aid 731Why LDC Recipients Accept Aid 735The Role of Nongovernmental Organizations in Aid and Evaluation 736The Effects of Aid 737

El Case Study: African Success Story at Risk: Botswana - ^ 739

15 Finance and Fiscal Policy for Development 750The Role of the Financial System 751

The Bumpy Road to Macroeconomic Stability 752

Differences between MDC and LDC Financial Systems 753The Role of Central Banks 756""The Role of Development Banking 758Informal Finance 760

Microfinance Institutions 761

i Reforming Financial Systems 764Financial Liberalization, Real Interest Rates, Savings, and Investment 764Financial Policy and the Role of the State 765Debate on the Role of Stock Markets 767

Fiscal Policy for Development 769

Macrostability and Resource Mobilization 769Taxation: Direct and Indirect 769

Public Administration: The Scarcest Resource 774

State-Owned Enterprises 776Improving the Performance of SOEs 777Privatization: Theory and Experience 778

Military Expenditures and Economic Development 780

0 Case Study: Privatization—What, When, and to Whom? Chile and Poland 784

16 Some Critical Issues for the Twenty-First Century 798Global Interdependence and the Growth of Developing-World Markets 798

The Global Environment and the Developing World 799Rain Forest Preservation as a Public Good: Who Should Pay? 801Searching for Global Solutions: The 1992,1997, and 2002 Summits

and Follow-Ups 803

Contents xxv

The Crisis in Sub-Saharan Africa 805Globalization and International Financial Reform 807Concluding Remarks 810

Glossary 815Name Index 845Subject Index 857